Strategy and Structure

Strategy and Structure is a classic management book.  It is about the evolution of structures suitable for managing large complex organizations.  The book gets across the idea that form should fit function in organizational design.  In asset management, it is the vehicle that should fit the time horizon and the liquidity of its underlying investments. Consider your time horizon when you are picking the vehicles for your own investments. If it is long enough to invest in illiquid assets and you have the sitzfleisch to do so, pick an appropriate vehicle.

Third Avenue Focused Credit Fund (TFCIX), which was closed on December 10th following its implosion, had a structure that was glaringly inappropriate for its investment strategy. Structured as it was, TFCIX was the apotheosis of investment malpractice. TFCIX held highly illiquid distressed debt and other low rated illiquid bonds in an open end mutual fund that offered daily liquidity. Although I believe that investing in distressed bonds and other illiquid, low quality debt is a sound strategy at times, it should be done in a vehicle that reflects its illiquid nature. TFCIX should have been a hedge fund with a long lock up, a closed end fund or an interval fund.

Most investments are, or should be, long term.  There is no reason that they need to be accessible at a moment’s notice.  Yes, a proper asset allocation should have liquid assets for current needs or emergencies, but those are likely to be a small portion of the overall portfolio.

The greatest investor of our time, Warren Buffett, owes some part of his success to the fact that he invests via those pools of long term stable capital known as insurance companies. He can navigate the tides without worrying about whether his capital will be redeemed. David Swensen of Yale built the endowment model of investing on a similar insight, the notion that long term investors can capture a premium for illiquidity. Neither of those great investors uses a liquid vehicle to invest in illiquid strategies, nor should you.


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